Question: I've been hearing a lot of good things about 'dividend aristocrats.' What are they, and should I be investing in them?
--Frankie, Tucumcari, New Mexico
Answer: Frankie, the name alone should tell you that these are a special group of companies. Standard & Poor's (S&P) did an exhaustive amount of research, seeking companies that manage to raise their dividends year in and year out -- even when the U.S economy slows. They found that these companies are likely to keep boosting their dividends at a steady pace, well into the future, rain or shine.
How A Company Becomes A Dividend Aristocrat
To be a 'dividend aristocrat,' a company must be in the S&P 500, have a market value of at least $3 billion and must have boosted its dividend -- by a little or a lot -- for 25 years straight.
Of the 500 companies in the S&P, less than 10% make the grade. The average dividend yield of these aristocrats is historically much higher than the yield offered by the other 450 or so companies in the S&P 500.
These companies offer up a unique twist. Not only do they generate steadily rising income streams, but they also tend to see their share prices rise in value at a respectable clip. After looking at data from the past 90 years, we found that dividend payments accounted for about one third of the wealth that these stocks have generated, with the other two thirds of the investment return captured by rising share prices.
A basket of these stocks has consistently delivered total returns that have outperformed the broader S&P 500. In fact, the S&P 500 Dividend Aristocrats index has outperformed the S&P 500 index over three-, five-, 10- and 20-year periods on a total return basis.
Offense And Defense
Part of the charm of owning stocks that sport rising dividend yields is their broad-based appeal in bull or bear markets. In a bull market, these stocks tend to rise in tandem with the broader averages. And when the market slumps, investors are inclined to sell other stocks and hang on to their dividend-paying stocks as buy-and-hold investments. That means they're less subject to the wild price swings that other stocks have generated in recent years.
And whereas other dividend-focused strategies tend to tie investments to a particular industry such as utilities, real estate (REITs) or energy Master Limited Partnerships (MLPs), the dividend aristocrats are involved in a wide variety of industries. This removes the risk of your portfolio being tied to just a narrow slice of the market.
So should you invest in aristocrat stocks? The answer is a qualified yes. These companies are surely tried-and-true winners, but they've also become especially popular in recent years as the relative yields of fixed income investments like bonds and CDs have slumped toward zero.
Final Thought
The stocks that qualify as dividend aristocrats typically don't offer the most robust dividend yields. Yet unlike the higher yielders that possess more limited growth prospects and may boost their dividends only modestly, dividend aristocrats appear to be in a very good position to steadily boost their dividends at a faster pace. Own them now and you may be stunned to see what kinds of dividends they are generating a decade or two in the future.
